Implementing monetary policy in times of crisis
The global financial crisis that began in August 2007, the subsequent euro area sovereign debt crisis and, most recently, the COVID-19 crisis necessitated strong policy responses, including corresponding monetary policy action. The Eurosystem thus adopted nonstandard monetary policy measures to support the effective transmission of monetary policy decisions to the financial system, the real economy and the levels of inflation. These nonstandard measures have been part of the Eurosystem’s toolkit ever since.
For the Eurosystem, the need to take nonstandard measures arose in 2007, when the policy rates set by the Governing Council of the ECB failed to be effectively transmitted to the economy as a whole. All nonstandard monetary policy measures the Eurosystem has taken since then have been in line with the operational monetary policy framework that had already been in place before 2007. Moreover, all the Eurosystem’s nonstandard measures have been adopted to serve the very objective the Eurosystem pursues with its standard policy measures, namely to achieve price stability, i.e. an inflation rate of 2% in the medium term.
Apart from nonstandard measures, the Eurosystem's monetary policy framework generally provides for a number of mechanisms that counterbalance potential stress in the financial sector, such as, for instance:
- The range of counterparties defined as eligible for Eurosystem refinancing operations enables a large number of banks to obtain direct central bank funding if the interbank market were to become dysfunctional.
- Eligible assets have been defined in a broad manner to facilitate bank refinancing with the Eurosystem.
- Overnight liquidity can be obtained not only on the interbank market but also directly from the Eurosystem, against eligible assets, through the ECB’s marginal lending facility.
Which were the Euroystem’s nonstandard monetary policy measures in response to the global financial crisis and the euro area sovereign debt crisis?
The main measures comprised
- extending the maturity of liquidity-providing operations:
Maturities of up to four years facilitated bank refinancing and supported longer-term planning and lending.
- changing the allotment of funds:
Since October 2008, all refinancing operations have been conducted as fixed rate tenders with full allotment. This ensures that, subject to adequate collateral, banks have unlimited access to central bank liquidity.
- extending collateral requirements:
The list of collateral eligible for Eurosystem refinancing operations was extended following the onset of the financial crisis, thus allowing banks to use a higher proportion of their assets to obtain central bank liquidity.
- lowering policy rates below the zero lower bound:
While the interest rate for main refinancing operations was lowered a number of times in 2008 and 2009 as well as in the period from 2011 to 2016 until it reached the zero lower bound (i.e. 0%) in March 2016, the interest rate for the deposit facility was reduced to –0.5% as late as in 2019. Given banks’ high amounts of excess liquidity, money market rates at that time stayed close to the lower bound of the policy rate corridor, which means that they were also pushed down to –0.5%. This eased banks’ refinancing conditions and enabled them to pass on their cost advantages to their customers in the form of lower lending rates.
- conducting targeted longer-term refinancing operations:
Since September 2014, the Eurosystem has been offering targeted longer-term refinancing operations at particularly favorable conditions (e.g. with an interest rate below the main refinancing rate) subject to conditions that stimulate bank lending to the real economy.
- enabling currency swap agreements:
Since 2007, euro area banks have been able to obtain funding from the Eurosystem not only in euro but also, repeatedly, in foreign currencies, such as the US dollar or Swiss franc, based on underlying currency swap agreements with other central banks. In 2011, six central banks or central banking systems – the Bank of England, the Bank of Canada, the Bank of Japan, the US Federal Reserve System, the Schweizerische Nationalbank and the ECB – concluded currency swap agreements, enabling the participating central banks to obtain currency from one another. In 2013, the ECB also concluded a currency swap agreement with the People’s Bank of China. In times of crisis, currency swap lines are instrumental in safeguarding financial stability and in preventing market tensions from affecting the real economy.
- purchasing sovereign bonds to reduce risk premiums:
In May 2010, the ECB launched a Securities Markets Programme (SMP) in response to tensions in some financial market segments, in particular the euro area sovereign bond markets. In fall 2012, the SMP was replaced by outright monetary transactions (OMTs) to specifically support the sovereign bond markets of euro area countries subject to relevant European Stability Mechanism (ESM) programs, with secondary market purchases.
- introducing asset purchase programmes:
Three successive covered bond purchase programmes (CBPP1-3; between 2009 and 2022) and an asset-backed securities purchase programme (ABSPP; between 2014 and 2022) were put in place to revive and support the respective refinancing markets, which are of great importance to European banks. Under the ABSPP, the Eurosystem purchased a broad range of simple and transparent securitized assets, with underlying assets consisting of credit claims against the euro area nonfinancial private sector. Under the CBPP3, the Eurosystem purchased a broad range of euro-denominated covered bonds issued by banks domiciled in the euro area.
Between 2015 and 2022, the Eurosystem expanded its asset purchases to include bonds issued by euro area central governments, agencies and European institutions (public sector purchase programme – PSPP) to address the downward trend in inflation expectations. In June 2016, the Eurosystem added a corporate sector purchase programme (CSPP) to the asset purchase programme framework. The CSPP comprised purchases of bonds issued by nonbank corporations established in the euro area. It aims at further strengthening the pass-through of the Eurosystem’s asset purchases to financing conditions in the real economy.
Since 2015, the CPBPP3, ABSPP, PSPP and CSPP have been combined to form the Eurosystem’s asset purchase programme (APP).
Financial instruments the Eurosystem bought under any of these programs had to meet certain minimum quality requirements.
- providing forward guidance:
Since its press conference of July 2013, the Governing Council of the ECB has been providing guidance on the future path of its monetary policy stance at its regular press conferences. This enables ECB policies to have an impact on interest rate expectations beyond the short horizon, i.e. to steer not only the very short-term money market rates but longer maturities as well.
- adopting a two-tier system of reserve remuneration:
Between 2014 and 2022, euro area banks were charged interest equivalent to the interest rate on the deposit facility for excess liquidity held on Eurosystem accounts. To alleviate the direct cost of negative interest rates for banks, the ECB adopted a two-tier system for remunerating excess liquidity holdings between September 2019 and September 2022, thus exempting part of banks’ excess cash reserves from the negative deposit facility rate.
Which were the Eurosystem’s nonstandard monetary policy measures in response to the coronavirus pandemic?
While drawing on the existing instruments (as described above), the Eurosystem’s monetary policymakers also expanded their toolkit and eased the conditions for the nonstandard measures already in place.
- To enable banks to meet their immediate liquidity needs, the Eurosystem offered additional long-term refinancing operations (LTROs), starting in spring 2020. In addition, pandemic emergency longer-term refinancing operations (PELTROs) were introduced to provide liquidity in 2020 and 2021 at an interest rate below the main refinancing rate and without conditions.
- At the same time, more favorable terms were applied to targeted longer-term refinancing operations outstanding from June 2020 to June 2022. This measure supported, above all, those economic players affected most by the spread of the coronavirus, in particular small- and medium-sized enterprises.
- The list of eligible collateral accepted in Eurosystem refinancing operations was extended further. In particular, the framework for additional credit claims (ACCs) was expanded to include bank loans (even small loans) to firms.
- The network of currency swap lines first created in 2011 was reactivated, enabling the Eurosystem to offer euro area banks US dollar liquidity. This offer will remain in place as long as necessary to ensure the smooth functioning of US dollar refinancing markets.
- The Eurosystem’s ongoing asset purchase programme (APP) was expanded further to provide for additional net purchases, until the end of 2020, in the amount of EUR 120 billion, with a view to supporting favorable financing conditions for the real economy in times of heightened uncertainty.
- On top of that, the Eurosystem launched a pandemic emergency purchase programme (PEPP) under which it bought EUR 1.718 billion worth of securities between March 2020 and March 2022. Any asset classes the Eurosystem had been buying under the APP were also eligible for PEPP purchases. In short, the PEPP was a monetary policy measure aimed at countering pandemic-related risks to the monetary policy transmission mechanism and the outlook for the euro area economy.